2022 Is A Year of Investing Focused on the Outlook for Inflation

Updated: Feb 21

As of Dec 2021, Feds have signaled three rate hikes in 2022 with the first hike as early as March and that they end the pandemic era bond purchases in March, paving the way for 0.75% rate hike by 2022FYE. BoC is expected to raise interest rates before US Feds, keeping inflation target at 2%, with Canadian inflation expectation remaining high at 4.7% in the near term. BoE raised its key interest rate to 0.5%, saying it expected annual inflation to accelerate above 7% within months. ECB is expected to follow suit shortly. The spread between the 10-yr treasury rates and TIPS rate, a proxy for expected inflation, stood at 2.48% as of Jan 31, 2022.


US Expected Inflation
US Expected Inflation

The yield curve moved all over the place in 2021 with short-dated treasury yields advancing more relative to longer dated treasuries. 3-month yields remained relatively flat and 1 yr yield experienced the highest increase; 30 yr yields experienced the lowest increase. Hence, rates rose across all maturities, but shorter terms rates rose more than longer term maturities throughout the year.


US Treasury Rates and Yield Spreads in 2021
US Treasury Rates and Yield Spreads in 2021

Consequently, the 30 yr – 10 yr yield spread curve flattened during 2021. The US Treasury has indicated that it would cut coupon issuance across all maturities in Q1/22 with the largest cut in the 7 yr and 20 yr maturities.


Different Maturity US Treasury Yield Spread
Different Maturity US Treasury Yield Spread

Despite the decline in the pace of economic growth due to supply chain bottle necks and heightened inflation, a rise in interest rates due to an increase in real growth as opposed to a rise in inflation has a positive impact on public equities. With monetary velocity as indicated by the ratio of nominal GDP to M2 money supply at record lows, there is plenty of liquidity in the market to fund GDP growth in 2022.


Inflation


[1] Inflation will determine much of the investing methodologies and stock selection decisions in 2022. The outlook for inflation and the expectation of how it will playout throughout 2022 impact asset allocation decisions. Inflation can be measured in a variety of ways including the net change in CPI, PPI and the GDP deflator. All measures point to heightened inflation throughout 2021 and into 2022.


The expectation for inflation will drive many investment decisions this year. This expectation can be determined in a variety of ways including through surveys or the spread between the treasury bond rates and inflation protected treasury bond rates of equivalent maturity. Hence, expected inflation is predictable and it can be integrated into stock selection, investing and asset